Wage Increases in China: Should Multinationals Rethink their Manufacturing and Sourcing Strategies?

Rising wages in China have the potential to transform global manufacturing. Based on new research, Accenture looks at the extent of these changes and their likely impact, offering multinationals four strategic options to mitigate the effects.

Background

Global companies need to develop the ability to detect changes that could radically change the business landscape—and respond creatively. One such potential transformative shift is the increase in Chinese wages. China’s growth, and its determination to reduce its dependence on exports, has intensified competition for skilled labor in the country among both multinationals and local companies.

Accenture conducted a study to examine the extent of these wage increases across various industries, and the impact they are likely to have on China’s position as the manufacturing powerhouse of the global economy.

Findings

Assuming a minimum wage increase of 30 percent, margins for companies with a strong manufacturing base in China (that is, 30-100 percent production in China) are expected to decrease just 1 percent to 5 percent. This is because labor costs represent a small portion of the price for these firms. Such companies may offset the impact on margins by increasing their productivity, reducing costs and improving their supply chain processes.

Although China’s wages have grown faster than in many other low-cost countries, its hourly wage rates are still more competitive than those in the developed world, especially in industries that require unskilled labor, such as apparel. In fact, the absolute wage differential between China and developed countries is continuing to widen, and China’s wage level in the apparel industry represents less than 9 percent of the overall average wage in the United Kingdom or the United States, owing to historically lower base-wage levels in China.

Accenture expects that the price increase will remain minimal, with no significant impact on consumer demand. With the growing purchasing power of domestic Chinese consumers, the additional demand is expected to fuel price increases in the long term. However, such a trend may have a negative impact on margins for export goods that are manufactured in China.

Analysis

Evidence suggests that the impact of labor price volatility on end price or margin of goods manufactured in China by multinationals will be significant. However, this impact is unlikely to affect sourcing decisions given that increased efficiency is likely to offset these gains.

While some companies may consider shifting their manufacturing to other low-cost countries like Vietnam, Thailand, Malaysia and Indonesia, they will face a range of challenges such as less developed infrastructure in ports, roads and facilities; shortages of skilled workers; and political instability. Within China itself, multinationals may tend to locate more production facilities in the interior and western regions, where wages are lower than in the eastern region.

Recommendations

Accenture’s research suggests four strategic options to help manufacturers mitigate the effects of wage inflation in China:

Focus on operational excellence. Multinationals must use efficiency gains to offset wage inflation by fostering collaboration between functional areas, and enhancing productivity, efficiency and process optimization.

Expand across West China and the Association of South-East Asian Nations (ASEAN). Existing Chinese facilities can be complemented by plants elsewhere, helping to lower cost structures and increase flexibility across the region, which comprises Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Burma, Cambodia, Laos and Vietnam.

Optimize across the globe. Instead of moving production facilities out of China, multinationals could create centers of excellence to optimize the company’s global manufacturing footprint, focusing on a total-cost-to-serve model.

Grow the local market. As the Chinese market grows, multinationals could configure their supply chain management strategy to service this market from their Chinese facilities.

Accenture has decades of experience in helping leading companies turn their manufacturing facilities into a source of competitive advantage and an enabler of high performance. Contact us to find out how we can help your company do the same.

Authors

Jonathan Wright is a senior executive in Accenture Management Consulting with a focus on communications, media and technology across the Asia Pacific region, and running supply chain management across ASEAN. He has over 17 years of experience in Management Consulting especially global supply chain transformation, fulfillment strategy and network improvement. He has worked in the retail, communications, high tech, aerospace and defense, and health and life sciences industries. He is also recognized as a global thought leader in green and sustainable supply chains. He is based in Singapore.

Manisha Sahni is a manager in the Accenture Management Consulting Innovation Centre, where she has led research projects in banking and supply chain management. She has extensive experience in consulting projects across financial services, telecom and fashion industries in Asia and the Middle East. She is based in Singapore.

Rowena Zamora is a consultant in the Accenture Management Consulting Innovation Center. She has served as a key contributor in research publications in supply chain management, banking and human capital development. She is based in Singapore.